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Green Bonds FUNDAÇÃO GETULIO VARGAS CENTER FOR SUSTAINABILITY STUDIES (GVces / FGV-EAESP) Green Bonds OCTOBER 2015 FUNDAÇÃO GETULIO VARGAS CENTER FOR SUSTAINABILITY STUDIES (GVces / FGV-EAESP) PREPARED FOR FEBRABAN 3 PRODUCTION Compilation FEBRABAN Brazilian Federation of Banks Murilo Portugal Filho PRESIDENT Mario Sergio Vasconcelos INSTITUTIONAL RELATIONS DIRECTOR Alessandra Panza INSTITUTIONAL RELATIONS ADVISOR ORGANIZATION RESPONSIBLE FOR THE STUDY Fundação Getulio Vargas Center for Sustainability Studies (GVces) STUDY COORDINATORS Mario Monzoni, Annelise Vendramini COLLABORATION Ricardo Ratner Rochman STUDY TECHNICAL TEAM Fernanda Casagrande Rocha, Paula Peirão, Pedro Bono Milan ACKNOWLEDGEMENTS Grupo de Trabalho FEBRABAN Comissão de Responsabilidade Social e Sustentabilidade Comissão Intrasetorial Organizations and Institutions: ABRAPP, ANBIMA, Banco do Brasil, World Bank, BM&F Bovespa, BOAML, BTG, Caixa Econômica Federal, Citi, Climate Bonds Initiative, CNSEG, CVM, ICMA, IDB, IFC, Itaú BBA, Itaú Unibanco Asset, JP Morgan, KPMG, Ministry of Finance, Ministry of the Environment, Morgan Stanley, Previ, PRI, Santander Asset, Santander Brasil, Santander UK and Vigeo EDIÇÃO DE ARTE Marco Antonio Rodrigues (Miolo Editorial) TRADUÇÃO Liam Gallagher GVces. Green Bonds. Centro de Estudos em Sustentabilidade da Escola de Administração de Empresas de São Paulo da Fundação Getulio Vargas. São Paulo, p CONTENTS EXECUTIVE SUMMARY 6 PRESENTATION 9 I. GREEN BONDS: THE INTERNATIONAL EXPERIENCE Characteristics of the international GB market 17 II. THE BRAZILIAN DEBT SECURITIES AND GB MARKET The Brazilian debt securities market The challenges for the GB market in Brazil 28 III. PROPOSALS FOR MAKING THE DEVELOPMENT OF A GB MARKET FEASIBLE IN BRAZIL 34 VI. CONCLUSIONS 38 Bibliographical references 39 Exhibits 40 5 EXECUTIVE SUMMARY This study aims to contribute to the discussion about the opportunities and the limits to the development of a Green Bonds market in Brazil, in line with international experience. The research consisted of a bibliographical review, interviews with international participants in the Green Bonds market and with organizations in Brazil involved in capital markets, feedback sessions with members of the FEBRABAN Working Group and the opinions of the GVCes team. The first part of the report describes the features of Green Bonds prevailing on the international market; the second discusses the features of the Brazilian corporate bond market and the challenges to developing in Brazil a market for green bonds along the lines of international experience. The third part presents the conclusions and suggestions for developing this market in Brazil. The international experience: Green Bonds (GBs) Between 2010 and 2014, US$ 57.9 billion in GB were issued on the international market, which indicates the development and consolidation of an innovative market whose aim is to finance projects that adopt socioenvironmental criteria, thereby contributing to sustainable development. The GB market is attracting a new group of investors interested in acquiring bonds that comprise part of their green investment initiatives. Potential issuers of GB, those who detect opportunities for projects with socioenvironmental criteria in their business, are encouraged to issue this type of bond in order to bolster their reputation. Reputation involves image and reliability/credibility. This differential, in turn, can become an important competitive advantage for the organization. Moreover, GBs open the doors to a wider range of investors committed to responsible investment. The process for issuing GB differs from that of traditional bonds solely because of the need to hire a second opinion agent, who must attest that the prospective project fulfills the socioenvironmental criteria required for classification of the GB. The international GB market has grown and is now economically viable without the use of fiscal incentive mechanisms. Those countries where GBs prosper have similar characteristics, such as low interest rates, less macroeconomic uncertainty and lower market risk, with government securities that deliver lower levels of returns. Against this background, corporate bonds offer investors attractive returns and a favorable environment for raising long-term funds for investment projects with a socioenvironmental bias. Furthermore, greater awareness about socioenvironmental issues attracts the attention of major asset managers in search of returns, reputation, and shared benefits. Key aspects here are the legal certainty of markets that issue international GBs, the reputation and risk rating of the issuers, and the track record of funding using other instruments. The international GB markets do not require distinctive and specific legislation. As a result, they are founded on market principles in which the supply and demand for bonds are sustained by incentives perceived both from the point of view of the issuer and the investor. This situation is governed by a win-win logic which, above all else, provides society with socioenvironmental benefits. Why is the GB market facing development hurdles in Brazil? There are still some substantial structural challenges when compared with the international capital markets, not to mention the momentary challenges facing the country and which affect this class of investment. 1. Government bonds enjoy a different level of competitiveness over corporate bonds. 2. The low secondary market liquidity in Brazil hampers the development of the corporate bond market. 3. Highly concentrated investor market, with low participation by private individuals and foreigners. 6 1. The process for placing GBs on the market is extensive and comes with an additional cost (second opinion) 2. Lack of incentive for underwriters to structure a GB, in detriment of a traditional debenture. 3. Investors perceive a higher risk associated with GBs is the case of project financing for new technologies. Why should Brazil make a big effort to develop a domestic GB market? Although the Brazilian economy is currently experiencing a macroeconomic adjustment process witness the economic slowdown, high inflation rates and rising basic interest rates the government is looking for innovative ways to facilitate investment in the infrastructure Brazil needs. Add to this context the appearance of new business opportunities and investment projects which, naturally, will require private sector funding. The private sector needs to find new means of funding and, given international experience, GBs represent a way of diversifying investments which providing society with shared socioenvironmental benefits that are important for the transition to a sustainable economy. PROPOSALS TO FACILITATE THE DEVELOPMENT OF A GB MARKET IN BRAZIL The recommendations have been classified into i) structural proposals; and ii) specific GB proposals. It should be pointed out that all proposals are based on several assumptions described below. The assumptions adopted when preparing the proposals were: Structural agenda: Based on Brazil s current and historical economic scenario and the challenges underlined in this study, all proposals presented are channeled towards building a constructive agenda. This agenda is structured around the medium and long term and its aims are the development and competitiveness of a future GB market in Brazil. Thus, the proposals take into account, in the future, the convergence of aspects involving the economic scenario, such as the creation of savings and an increase in market liquidity, together with greater concerns about sustainability on the part of society and the institutions. GBs are products derived from the traditional fixed income market: GBs are traditional bonds with socioenvironmental criteria. As a result, it is assumed that the set of specific proposals for developing a GB market in Brazil lies within a much wider context, the bond market. The proposals for facilitating the GB market were analyzed so as not to aggravate the distortions and asymmetries that exist in the fixed income market: In the light of the foregoing, the proposals presented must not contribute to distortions that impact prices, transparency and access to the fixed income market. All assets of the fixed income market can, in theory, be green. It is generally accepted that any asset traded on capital markets can be configured as a green asset to the extent that it contributes to financing a sustainable economy and is backed up by a second opinion agent. However, in order to enjoy this classification, the socioenvironmental criteria must be measurable and assured, guaranteeing transparency in the use of the proceeds raised, which in turn must be in line with the principles of sustainable development. All assets must offer a competitive risk-return ratio in relation to traditional bonds. To engage with the mainstream market, and if a green bonds market is to effectively prosper in Brazil, the riskreturn ratio must be compatible and competitive in relation to traditional assets. Definition of a standard for the concept of socioenvironmental criteria and KPIs. A certain subjectivity still prevails when classifying projects that meet the criteria for socioenvironmental criteria. There is a need to define a protocol of eligibility criteria that engage with the financial and manufacturing sectors if a bond is to be considered green. Moreover, it is crucial for such criteria to abide by the international parameters already widely used. To kick-start the process for issuing GB in Brazil, it is suggested engaging with businesses that already have sustainability practices, good credit ratings and which need to raise funding. Besides financing specific projects with socioenvironmental criteria, GBs can also be used to finance a company s acrossthe-board sustainability strategy. 7 STRUCTURAL PROPOSALS Bearing in mind the work being undertaken by the Anbima, together with the Brazilian Securities Commission (CVM) for structural improvements to the Brazilian capital markets in general, GBs would benefit from: 1. Reduced asymmetry in tax incentives for different classes of investment. 2. Fewer hurdles to the placement of bonds in the market. 3. Better liquidity on the secondary market. However, one must draw attention to several specific proposals for developing the GB market in Brazil, bearing in mind the challenges in terms of scenario and structure that the Brazilian fixed income market needs to overcome. SPECIFIC PROPOSALS FOR GB 1. Creation of uniform guidelines for classifying GBs. In the case of a project classified under these criteria, the company could embark on a fast track and, as a reward, issue bonds much more quickly. Uniform guidelines would also have a positive impact on the work of the underwriter, who would have a much clearer idea of how to structure these products. Therefore, it is recommended developing a sub-chapter, within the rules and guidelines governing standardized debentures, that clearly sets out the criteria and indicators of projects with socioenvironmental criteria. Such uniform guidelines can take their inspiration from international experience, adapting this to the Brazilian context. 2. Development of local Second Opinion agents: it is important to encourage the creation of domestic second opinion agents that can work together with their international peers, thereby creating a locally competitive network. 3. Improvement in the risk perceived by investors with regard to socioenvironmental projects, by means of guarantees provided by multilateral institutions: Multilateral agencies, several domestic sector-specific funds that already exist, as well as the BNDES (Brazil s economic and social development bank) could become guarantors of some GB transactions for the purpose of disseminating green bonds on the domestic market. 4. Encourage anchor investors for GB issues: Engage with investor signatories of the UNPRI (Principles for Responsible Investment), in order for them to assist in boosting their demand. Multilateral institutions could also contribute to structuring the process of engaging with anchor investors. 5. Move ahead in disseminating information to agents involved in the GB market: Raise awareness and disseminate information about GBs to issuers, underwriters, and investors. The set of assumptions and proposals presented above aims to develop a GB market using solutions created by the agents themselves involved in this and without fiscal incentives provided by the government. This is about building a structured, long-term agenda that should enable a market to develop with few or no distortions. International experience within the context of GBs inspires the development of a market without recourse to fiscal incentives. Internationally, the market is advancing based on the cost-benefit status whereby investors are attracted by competitive rates to traditional bonds and place great store by the responsible allocation of the proceeds. Brazil, notwithstanding its peculiarities, must move forward towards establishing the GB market in Brazil, inspired in this international reality. Above all, it is crucial for the GB market in Brazil to grow in a credible manner, ensuring that the proceeds are invested in projects that go hand-in-hand with the principles of sustainability. If this is to come to pass, the second opinion agent will a key role as the market faces the challenge of coming up with solutions to ensure that the job gets done. 8 PRESENTATION In 2014, FEBRABAN and GVces agreed to a partnership to analyze possible ways forward for leveraging the transition to a Green Economy in Brazil, through the Brazilian Banking Sector. The outcome of this partnership was the publication, in April 2015, of a book that presented the results of three supplementary studies on the issue: the volume of funds allocated by the financial industry to the Green Economy as of 12/31/2013, the institutional and regulatory framework for the Brazilian Banking Sector regarding this issue, and the relationship between finance and sustainability in two sectors and on two economic issues: agribusiness, renewable energy, biodiversity and cities. Taking the FEBRABAN-GVces partnership to the next stage, this study seeks to contribute to the discussion surrounding the opportunities and limits to developing a market for Green Bonds in Brazil, in line with international experience. The study involved: i) a bibliographic review, especially reports on international issuances of Green Bonds and the outlook; ii) interviews with international participants in the Green Bonds market and capital markets organizations in Brazil, including private sector companies, sectorial organizations, banks, investors and government; iii) discussions with the members of FEBRABAN comprising the Working Group organized for this project; and iv) internal discussions among the GVces team. This report is divided as follows: the first part deals with the features of Green Bonds, based on evidence in the international market. The second part discusses the Brazilian corporate debt market and the challenges to developing in Brazil a market for green bonds in line with the international experience. In part three, the report concludes with proposals for developing this market in Brazil. 9 I. GREEN BONDS: THE INTERNATIONAL EXPERIENCE Developed on the international market, GBs represent a new way of diversifying investments. Sustainability is an issue of increasing interest in corporate decisions, and requires funds in order to finance projects with socioenvironmental criteria. It promotes access to several funding sources, including debt instruments, a method of financing among the most economical ways of accessing external financing, and for that reason frequently used in the corporate market 1. A traditional debt instrument is a fixed income security in which the bond issuer raises a fixed amount of funds from investors over a previously agreed time frame, remunerating them with interest payments (coupons) during the period. However, there is a rapidly growing global green securities market whose potential is estimated at 100 trillion dollars 2. The main difference between traditional and green securities, known as Green Bonds (GB) is the use of the proceeds. When issuing GBs, the issuer raises funds exclusively to finance sustainable projects, such as renewable energy, energy efficiency, sustainable waste management, low carbon transportation, forestry projects, etc. The bonds can also be used to finance social benefit projects, such as improved healthcare and social services. For more information about the use of proceeds, see the Exhibits. There are two sources of specifications that assist in qualifying projects eligible for GBs: the Green Bond Principles and the Climate Bond Standards. The Green Bond Principles represent a voluntary initiative that sets out guidelines clarifying the approach to issuing a GB. It recommends transparency and disclosure, in addition to fostering integrity in the market. Its executive committee consists of representatives of issuers, investors and intermediaries in the GB market, and is supported by the International Capital Markets Association (ICMA). The signatories to this initiative amount to over one hundred institutions, among them Blackrock Inc., KfW, the European Investment Bank, the World Bank, Bank of America-Merrill Lynch and JP Morgan Chase & Co.. The full list of the signatories to the Green Bond Principles can be found in the Exhibits. The Climate Bonds Standard is a tool for assessing the environmental integrity of bonds whose purpose is to mitigate and adapt to climate change. It consists of eligibility criteria for investments in solar and wind energy, transportation and green buildings. There are 34 partners in this initiative, such as Rabobank, Credit Suisse, Bloomberg and Allianz, among others. See the list of the Climate Bonds Standard partners in the Exhibits. When the bonds issued seek to specifically mitigate the impacts of climate change, they are frequently referred to on the global market as Climate Bonds. In this scenario, their purpose is to mitigate greenhouse gas (GHG) emissions in new projects, or adapt existing projects so as to reduce GHG emissions and allow gains in operational efficiency with low environmental impact 3. Thus GBs present a new way of diversifying investments. The bonds can be issued by governments, banks, supranational institutions, public sector and private sector corporations, while the remunerations conditions and characteristics are decided during the issuing process. 1 (Petrasek, 2010) 2 (Climate Bonds Initiative, Accessed in 2015b) 3 (Mathews & Kidney, 2010) 12 The bonds can be structured in four different ways: Green Use of Proceeds Bonds, Green Use of Proceeds Revenue Bonds, Green Project Bonds or Green Securitized Bonds. Their respective features are shown in detail in Table 1. TABLE 1. CLASSIFICATIONS OF GREEN BONDS TYPE Green Use of Proceeds Bonds USE OF THE PROCEEDS Intended for sustainable projects BOND COLLATERAL Guaranteed by the issuer, and an assessment and credit risk score by independent agencies Green Use of Proceeds Revenue Bonds Green Project Bonds Green Securitized Bonds SOURCE: CLIMATE BONDS INITIATIVE Intended for sustainable projects Specific sustainable project Intended for sustainable projects or some specific sustainable project Cash flow from the project as collateral for the transaction Project assets and financial information Group of assets and cash flows It is worth pointing out that, in the case of Green Corporate Bonds, more than specific projects their aim is to finance the entire sustainability strategy of a company. These bonds are classified as Green Use of Proceeds Bonds. The differential of GBs is not to raise cheaper funding, but to be a b
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